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VM switch shrinks Nomura's balance sheet

Nomura started treating variation margin on certain cleared swaps as settlement of these trades and shifted some client margin off the books in the second quarter – accounting tweaks that cut ¥247 billion ($2.2 billion) from its end-March balance sheet.

The Japanese bank changed its margin accounting policy as of April 1 to subtract some cash collateral held on behalf of clients from its total assets, and an equivalent amount reflecting its obligation to pay back the collateral in future from its total liabilities. The bank restated its end-March balance sheet to reflect the switch, cutting ¥237 billion.

Nomura also adopted the settled-to-market (STM) technique for cleared swaps traded in Japan. The bank’s end-June earnings presentation stated that daily variation margin on certain derivatives cleared through a specific clearing house were now no longer recognised on balance sheet, following an amendment to this clearing house’s rules.

The change cut trading assets and liabilities reported at end-March by ¥4.9 billion and ¥10.4 billion, respectively, and an extra ¥5.5 billion from other assets.

It is understood that Nomura was already using STM to discount variation margin on cleared swaps traded in the UK and US, but that the Japanese regulator had only recently greenlighted the use of the technique for onshore transactions.

What is it?

Cleared swaps routed through central counterparties that allow STM are cut from banks’ derivatives assets and liabilities, as the outstanding mark-to-market of such positions are considered settled at the end of each day. The technique effectively moves the variation margin payments off-balance sheet.

Why it matters

The settled-to-market technique has taken the derivatives world by storm. Dealers have embraced the shift as it allows them to shrink their balance sheets, and in turn their total leverage exposures, which are used to set leverage-based capital requirements. But use of STM to reduce these exposures is contingent on the approval of local regulators. The Federal Reserve gave a thumbs up to the practice in August 2017, and the European Central Bank is in discussions with EU member states authorities on the technique, too.

We're still in the process of pinning down when the Japanese authorities gave their consent to the practice, and which local clearing houses have amended their rules accordingly. For now, it's safe to say that settled-to-market is well on its way to becoming a universally accepted doctrine.